Direct cost vs Indirect Cost

Difference between Direct cost vs Indirect Cost

Businesses incur costs while generating revenue. If we look at the cost sheet of the company, we will see that total cost is a combination of direct cost vs indirect cost. These costs are very important for running any kind of business.

A direct cost is attributable to a specific product or service. For example, the cost of raw material used for manufacturing a product is a direct cost. An indirect cost is a cost that is not directly identified with a single or cost objective but identified with two or more final cost objectives or intermediate cost objectives.

In this Direct cost vs Indirect Cost article, we will try to understand the comparative analysis between direct cost vs indirect cost:

Head to Head Comparison Between Direct Cost vs Indirect Cost (Infographics)

Below is the top 6 difference between Direct cost and Indirect Cost

Key Differences

Both are part of total costs; let us discuss some of the major differences:

• A direct cost is a specialized form of cost that only uses variable costs to make decisions. It does not consider fixed costs, which are assumed to be associated with time periods in which they are incurred. Indirect costs use only fixed costs to make decisions.
• The best way to determine whether a cost is a direct cost is to compare changes in the cost to changes in the associated cost object. Indirect costs are costs used by multiple activities and cannot be assigned to specific cost objects.
• The direct cost concept is extremely useful for short-term decisions but can lead to adverse results if used for long-term decision making, as it does not include all costs that may apply to long-term decisions. On the other hand, the indirect cost concept is useful for short-term as well as long-term decision-making. Indirect costs are those necessary to keep your business in operation.
• Direct costs do vary significantly within certain product volumes therefore considered to be a variable cost. Conversely, indirect costs do not vary significantly within certain product volume or other activity indicators and are therefore considered a fixed cost.
• The operating leverage concept measures a company’s composition of fixed cost and variable cost in total cost. If a large portion of the company’s costs is fixed cost (indirect cost), then it has high operating leverage and also the company can earn a large profit on each incremental sale, but it must attain sufficient sales volume to cross breakeven point. On the other hand, if a large portion of company’s cost is a variable cost (direct cost), then it has low operating leverage, and the company earns a smaller profit on each incremental sale but does not have to generate much sales volume in order to cover its lower fixed cost.
• Direct costs are easily traceable as per the cost object. However, indirect costs can’t be identified easily.
• As an example, we can say that direct costs are the costs incurred for the raw material used in product manufacturing. Since one can directly attribute how much costs are expenses per unit of raw material, we call it direct cost. On the other hand, an administration expense is an indirect cost since it is incurred for the organization as a whole.

Direct Cost vs Indirect Cost Comparison Table

Below is the important comparison between Direct cost vs indirect cost

Basic Comparison	Direct Cost	Indirect Cost
Meaning	Any cost that is directly or easily attributable to a product/service is called a direct cost.	Any cost that is not easily attributable to a particular project/service is indirect.
Example	Raw material cost, transportation cost, sales commission etc.	Rent, administrative, office and accounting expenses etc.
Nature	Variable cost (Vary with product volume)	Fixed cost (Do not vary significantly with certain product volume)
Identifiable	It can be identifying easily.	It cannot be identifying easily.
Expended on	Particular cost object.	Multiple cost object.
Aggregate	The total of all the direct costs is called as prime cost.	Total of all the indirect costs called as overhead.

Conclusion

For operating any business understanding the direct cost vs indirect cost is very important. Because while operating a business, if you don’t know how to allocate costs and attribute them properly, it would be very difficult to find out the profit per unit after selling products or services.

Direct costs are identifiable and useful for taking any short-term decisions but cannot be used for taking any long-term decisions, as it does not include all other costs that may apply to long-term decisions. Therefore, the main challenge while operating a business is indirect costs. Indirect costs are unidentifiable costs, the business can see how much they can expand on a long-term basis, and then they can measure the profits.

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